30% Today Versus 50% Tomorrow:

byBrad FerrisonSeptember 13, 2016

By far the most common question I’ve ever been asked is when to sell a stock. Readers, friends or colleagues want to know a simple, straightforward and successful approach where they can earn money and continue to apply the rule for long-term success. This post outlines one of the major strategies I implement for selling investments in my portfolio and those I manage.

Years back there was a significant amount of discussion between members on a Canadian investment forum about when an investment should be sold. At that time we were facing rapidly rising commodity prices and equity valuations with some investors being critical of others selling out of energy/other commodities after significant appreciations. The belief was that fundamentals would continue to drive prices higher.

In retrospect this post couldn’t have been timed more perfectly; the financial crisis of 2008 hit only weeks later. I have always assumed that each investor holds the same intention of wanting to make money, especially since I have yet to meet someone who purposely enjoys losing it.

But how much performance is enough? When should you take advantage of profits or hold out for more?

Imagine for a moment that you were a buy-and-hold investor who initiated a position in Nortel during a low period in October 1998 and promised yourself not to sell for 10 years. You would have watched happily as your investment reached its high during the technology bull market in March 2000 after an appreciation of over 375% on your original investment. Check back on its close for 2001 and not only would that 375% have evaporated, but you would be down a stunning 75% from your original purchase price. While an extreme case this provides an excellent example of why investors should look to take profits regardless of their opinions on how much further a stock has to gain and regardless of stated fundamentals by analysts, advisors or opinions in the market.

Rule #1: Never Lose Money

Rule #2: You Only Make Money When You Sell

Rule #3: Collect Dividends (for reasons see #1 & #2)

Gains on investments are a touchy subject for investors and many never stick to a general rule or discipline in when and where they take profits. I advocate for buy and hold for the long-term, but we all need a strategy to sell. What can prevent an investor from selling can be fear of the tax implications of selling at a substantial gain, costs incurred by commissions, anxiety of missing perceived future gains or uncertainty of where to place cash in an environment of continuing market highs or cash low returns. The end result usually is the wrong decision or we miss an opportunity and this increases the chances of more emotional decisions in the future.

The best practice I was able to witness and practice is that of a portfolio manager or someone who concentrates on asset allocations to trim positions as they appreciate to maintain an equity in a range within a portfolio; commonly 3-5%.

Once an investment becomes overweight, say 6-8%, a portion of those shares are sold for a gain to bring back the allocation to the desired target. Proceeds are then re-invested back into under allocated positions to rebalance the portfolio. This prevents one sole investment from becoming too much of an overall portfolio and helps to minimize non-systematic risk. I have always maintained that regardless of how well a stock performs over the short-term I never hesitate to sell a portion or all of your position (see Rule #2). I will always take 30% today in my pocket and look to re-enter a position at another time versus the uncertainty that my purchase might continue to appreciate.

Selling early may seem foolish if you believe the fundamentals remain strong, but in the stock market unknown factors are risks. Risk has the potential to decimate returns for an investor (see Rule #1). Consider stock ABC. You buy a position in ABC for $10 a share, you’ve done your situational analysis, it fits your investing objectives and you intend to hold the stock for the medium term (1-3 years). Three weeks later ABC’s industry competitor MNO agrees to a friendly takeover by larger rival XYZ. Not only does MNO’s stock price soar, but ABC follows to $13.50 a share as the market speculates more acquisitions within the industry are imminent. The question I pose to readers is: what do you do as a shareholder of ABC? I would expect most investors to answer this question by stating that they’d sit on the shares in the hopes of a higher price. But consider what could happen if XYZ’s financing fell through, regulators place limitations on the acquisition or no further consolidation occurs? What if the economic environment changes and margins were to significantly decrease?

You can sell today for guaranteed return of 35% or hold out hoping for more. In this situation hope equals risk and you have to know what risk you’re willing to take in this situation for your perceived gain in the future even if you feel ABC is worth $15. An investor always has the option of re-entering a position later with their original capital intact and proceeds in their pocket. (see Rule #2)

One of my clients faced a situation in 2015 when Baxter (BAX) spun off Baxalta. In January of this year (‘16) Shire PLC offered $32 billion for Baxalta which at that time worked out to ~$45.50 per share. My clients’ book value (in the portfolio) for the BXLT shares was $35. The shares were trading in the $40 range throughout this process representing a current gain of 14% gain and a still yet to captured 13% gain. My client had a fair lot of uncertainty of how to proceed and the options were numerous. We discussed a few options which included selling 50% of the shares in March (‘16) at $40, another 25% in May (’16) at $42 and the remaining 25% a week before the scheduled transaction at $45.

The main goal was to capture gains as best as possible without exposing my client to any unnecessary risk. At one point I advocated for selling the whole position at $42 seeing the $3 premium as an unnecessary risk. There wasn’t a purely right or wrong answer because this was a fairly straight forward transaction, but Pfizer had just walked away from a deal with Allergan (April ’16) giving the market pause on current pharmaceutical mergers. The question I posed was, “Is 5% worth the risk premium for you to wait?”

Scottposed a question in a 2007 post on the topic of setting a sell target and why we stick to prices so passionately as investors.

“If your view if that stock is a sell, why are you being so sticky on price…reaching for a few dollars more? When the stock was trading at $29, your view was that the stock was a sell and so you entered a limit order for $33. Now the stock is trading at $25 and you’ve moved down the limit to $29. Why is the stock less of a sell at $25 than at $29 or at $29 than at $33?”

I don’t hesitate to sell out of a position for a guaranteed gain; plain and simple. On more than one occasion each year I sell out of positions I’m holding after a stock runs up 30% over a short period of time. The company is still one I want to own, but the valuation has changed too quickly to not capture profits. In my mind I’d rather take the guarantee today and always re-enter a position if the valuation dips or remains stable. Most recently I completed this with TransCanada Pipeline (TRP) and Manulife Financial (MFC). TRP I bought just after President Obama rejected the planned XL Pipeline in November of 2015. Manulife I purchased in January of 2016 during the overall market decline. By May of 2016 I had booked gains of 30% and 20% respectively in positions I didn’t consider as core holdings, but I took advantage of at attractive valuations after favourable market conditions. TRP has continued to appreciate while Manulife has traded in a volatile range of ~18%. Long-term neither was necessary but this prudent approach adds to the accumulation of gains over long periods of time.

Profits should be admired instead of criticized.

I look for opportunities to take profits in stocks that have moved from significantly under-valued to over-valued because I never know when the next opportunity to buy an undervalued stock might present or what unforeseen events might occur in a company I hold. In my view a 10-15% chance of making more on a stock tomorrow versus a guaranteed return today simply isn’t worth the risk in most situations. An investor should be constantly aware of their downside risk and be ready to ask if it is worth sitting and waiting versus taking your money elsewhere and looking for better long-term opportunities. It’s not always about the big gains but the small cumulative tasks you practice that leads to the appreciation of your portfolio

All you need to do is hold a stock too long once and you realize the merit in this approach. Remember; even when you invest without emotion it can be difficult at times to resist the temptation to sit in a little longer awaiting a better price. Put on your Portfolio Manager Hat and make the right move. You’ll be rewarded in the long run. The bottom line: As an investor you have to protect yourself against risk because no one else is going to do it for you. 30% today vs. 50% tomorrow might appear as a foolish decision at a time when all the hype surrounding a stock pushes momentum further and further, but there will always be another stock, another opportunity and risk at times is completely dependent on factors you cannot see or anticipate.

Selling ¼ to ½ of your position in a stock during a significant appreciation in the share price to lock in profits is never a foolhardy decision and likely something more of us should aspire to achieve as disciplined investors. Watch your trading costs and capital gains (if applicable), but taxes and costs should not be the sole driving influence for not adopting a strategy such as this. Remember you’re investing to compound your returns and reinvesting those proceeds back into your portfolio helps you accomplish that task.

This post was originally published on July 21, 2008 and was republished with revisions

Thanks Anon. Its a general rule of thumb that led to some very good gains in my Value Portfolio over the past 2 years. It’s all about capital preservation because you never know what might be around the corner.

I noticed some of my mutual funds are showing a 70% return from one year ago (market low). Do you agree it's a good time to sell some now and wait for a dip in the major indexes before getting back in? I'm of course talking about my funds invested in US equities.John

Well said and I agree Nurse B 911 with key point of preserving capital. My first mutual fund of $100 I sold for a few dollars. I was happy that I made more than 30 days of interest compared to a savings account.

Progressing forward into stock investing with brokerage account I was just happy to have the number of trades and reduced commission fee's in starting to invest and build experience; all the while preserving my capital.

Saying "Oh should have waited to sell" or "Missed that opportunity" is easy but keeping in mind one cannot always time the market and the unknown is always to be expected; selling and making any profit is better than nothing.

I have sold positions as a result of emotions, reduction of risk, dislike of company(s) new direction, investment cycle(s) and or course profit. The profit may be small, large and even a loss in some cases (overall portfolio is positive and changed accordingly).

I consider loss if 20% change in value and I consider profit in 3%-10% usually with my experience/comfort level (Newbie DIY). Capital gains above annual dividend percentage return and above inflation are great; even greater when taxes taking into consideration.

Preserving capital, having profits to re-invest (if chosen) with market dynamics is so true. Thank-you for wonderful write-up.